India’s crack down on ‘black money’: has it hurt those it sought to help?

Following the disclosure of Google’s tax returns and the publication of the Panama Papers, the issue of tax evasion has increasingly come to the fore. Compounded by rising economic inequality and cuts to public services, a growing number of people in the UK have demanded that wealthy individuals and multinational corporations ‘pay their fair share’. However, the debate surrounding tax evasion has not been confined to developed nations. In fact, recent events in India suggest that the problem may be far more damaging in emerging economies.

While tax evaders in the UK funnel undeclared income into offshore bank accounts, their Indian counterparts use the cash-centric informal market to conceal cash, otherwise known as ‘black money’. Due to the dominance of this ‘shadow economy’, responsible for up to 40% GDP and nearly 80% employment, less than 3% of Indians pay income tax (although it should be noted that many do not even meet the required threshold). In other words, the entrenchment of India’s informal economy limits the government’s ability to fund vital healthcare, education and infrastructure projects. As a result, unregulated and untaxed monetary transactions may be preventing millions of Indians from escaping poverty.

On 8th November 2016, Donald Trump was hours away from becoming President-elect. But in New Delhi, Prime Minister Narendra Modi was staging an ambush of his own. During a televised announcement, he declared that all 500 and 1000 rupee notes would cease to be legal tender the following day. He also outlined a 50-day period in which voided currency could be deposited into a bank account, or exchanged for newly printed 500 and 2000 rupee notes. With only around ten trusted officials aware of the incoming demonetisation policy, it was Modi’s intention to catch ‘black money’ hoarders off-guard. Large amounts of cash would be deposited, taxed and potentially fined, or simply rendered worthless.

Most notably, there were not enough replacement banknotes available in ATMs. According to one report, even if the Reserve Bank of India continuously printed money 24 hours a day, it would take four months to a year before the currency supply was completely restored. With 90% of all transactions made through cash, millions of everyday Indians struggled to purchase goods or receive their wages.

Yet even if there had been enough replacement banknotes printed, the country’s poorest rural communities would have still suffered disproportionately. After travelling to surrounding cities to exchange banknotes, many Indians did not have the required ID cards to obtain new currency. Those who did not make the arduous journey grappled with the collapse of vital rural industries, such as agriculture and fishing. The scarcity of banknotes resulted in farmers being unable to purchase new seeds, and the crash in crop prices forced farmers to dump their products in desperation.

Anna Hazare Anti-Corruption Rally, Delhi | Ishan Khosla

As India’s poorest struggled to respond, data from income tax probes found that ‘black money’ holders kept only 6% or less of their wealth in cash. Worse still, many of those with untaxed cash reserves found ways to avoid declaration through purchasing gold, donating to temples or backdated accounting. With tax evaders adjusting with relative ease, criticism towards Modi’s demonetisation programme extended not only to its implementation, but also its design.

Billed as a way to fight tax evasion, boost revenue and help India become a cashless society, in many respects, demonetisation achieved the exact opposite. Reports that digital transactions fell over 10% in January 2017 indicate that the curbing of the informal economy may have only been temporary. Indeed, implementing such a radical policy in a notoriously bureaucratic country, which makes up one-sixth of the world’s population, was never going to be easy. But with India split between the well-connected city dwellers of Bangalore and the isolated village of Rajasthan, providing incentives to adopt bank accounts and taxable systems of exchange may have been more effective. Such initiatives have proved successful in Mexico, South Africa and even in India, where the government offered free life insurance to people opening a bank account for the first time.

Rather than reverting to the ineffective demonetisation programmes of 1946 and 1978, the Indian government should be supporting schemes that are benefiting its citizens right now. Through boosting tech education, incentivising e-commerce, and targeting tax evaders, India will be able to reduce ‘black money’ – without hurting its poorest.